Question

It will be helpful if you can assist me with the following questions:

If the market is in equilibrium, the market value of a common share should always equal its book value.

True

False

All common shares in an equivalent risk class should be priced to offer the same expected return, if the market is in equilibrium.

True

False

Williams Inc. is expected to pay a dividend of $4.10/share next year. Analysts believe that dividends will grow at a 6% rate indefinitely. Would you be willing to pay $30 for this stock if your required rate of return is 20%?

		Yes
		No
		You'd be indifferent towards purchasing the stock.
		Cannot be determined.

Which one of the following is correct concerning the nonconstant dividend growth model?

		The first growth rate must be higher than the second growth rate.
		The time value of money is ignored.
		The discount rate ignores the risks associated with an individual firm.
		The discount rate considers the risk-free rate of return.

Answer 1

Answer 1:- True

Explanation:- Equilibrium is the situation where the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock. If a stock is in equilibrium then there is no fundamental imbalance, hence no pressure for a change in the stock’s price. However, most of the times stock prices and equilibrium values are different, so stocks can be temporarily undervalued or overvalued.

Answer 2:- True

Explanation:- All stocks in a particular risk class must offer the same rate of return. If a certain stock, for example, is priced above others in the equivalent risk class, investors would sell their shares to buy cheaper shares from companies in the same risk class. This would force the price of that higher priced stock down to the equilibrium price. The same happens for a stock priced below equilibrium—investors would rush to buy the stock, sending its price back up. So, in case of equilibrium in well-functioning capital markets, all common shares in an equivalent risk class should be priced to offer the same expected return.

Answer 3:- Yes

Explanation:-

Value of stock= Expected dividend per share / (Required Rate of return - Dividend growth rate​)

Value of stock = $4.10 / ( 20% - 6%)

= $4.10 / 14%

= $29.28 ( which is approximately $30)

So, one would be willing to pay $30 for this stock if the required rate of return is 20%

Answer 4:-  The first growth rate must be higher than the second growth rate.​​​​​​

Explanation:- The growth rate in initial stage is generally assumed to be quite aggressive, reflecting the company’s swift expansion, while with the coming times the second growth rate assumes a lower, more sustainable rate of dividend growth. So, this statement is correct concerning the non-constant dividend growth model.